Editorials

Empower outside directors

An amendment to the Corporate Law, proposed by the Legislative Council to Justice Minister Takashi Yamashita earlier this month, would impose a legal obligation for the first time on big companies to have an outside director on their executive board. Since nearly 98 percent of all firms listed on the Tokyo Stock Exchange already have at least one outside member on their board of directors, the measure has only a symbolic meaning — perhaps to show that Japan is making efforts to beef up corporate governance and build investor trust in companies’ management. However, just the presence of an outside director won’t prevent corporate scandals or wrongdoing from taking place. The question is whether such directors indeed play their intended role of providing independent management oversight.

Introduction of outside directors to Japanese boards gained momentum after the 2008 collapse of Lehman Brothers triggered the global financial crisis and recession. The Corporate Governance Code introduced by the TSE in 2015 to set a code of conduct for listed firms, meanwhile, called on listed companies to have at least two highly independent outside directors on their board to improve their management oversight. While the code is not binding, the firms that do not comply are urged to provide investors with a rational explanation why.

As a result, the ratio of companies listed on the TSE’s first section that have two or more outside directors on their board rose sharply, from 18 percent in 2013 to 79.7 percent in 2016 and to 91 percent last year. Doubts are often raised, however, whether these outside directors are in fact serving their expected function of overseeing management from the viewpoint of a third party not involved in the firm’s inner workings.

Toshiba Corp. was long reputed as a leader among Japanese firms when it comes to corporate governance measures, bringing in multiple outside directors to its board much faster than other companies. But that did not appear to have had a positive impact on its corporate culture: The firm was hit by a major accounting scandal in 2015 in which the firm’s profits were padded by roughly ¥150 billion over several years under pressure from its top management. This shows how it is actually quite difficult for outside board members to play their expected role of monitoring management decisions from an objective standpoint and finding or correcting mistakes and illicit conduct.

The proposed amendment to the Corporate Law would also require a company’s board of directors to decide the policies for remunerating board members, and publicly disclose the policies and the pay. The issue of executive pay — and the transparency with which the salaries are decided in some companies — came under the spotlight following the arrest of then-Nissan Motor Co. Chairman Carlos Ghosn for allegedly underreporting his remunerations for years.

After the arrest of Ghosn on that and other charges that raised questions about corporate governance at the major automaker, Nissan is reportedly considering increasing the number of outside directors from the current three. However, the charges against Ghosn, who is alleged to have wielded unquestioned power within the automaker, including in deciding executive pay effectively at his own discretion, also put into question whether the outside directors have been able to play substantial roles in overseeing the firm’s management.

The arrest and indictment last year of a former outside director of an electric parts manufacturer listed on the TSE’s first section, on charges of insider trading of the firm’s shares based on confidential information he obtained thanks to his position — also highlighted the question of the quality of outside directors that companies are bringing in.

Many companies are believed to look for candidates among top executives of other firms, academics and lawmakers. The companies often reportedly face difficulties finding the right person with sufficient knowledge and expertise on corporate management. In fact, many well-qualified people are reportedly serving as outside directors at several companies simultaneously. Another question is whether the companies that tap them have established an in-house environment in which these directors can fulfil the roles expected of them, such as by providing them with sufficient access to the firm’s relevant information or by enabling them to be regularly heard by the company’s top management.

Merely making it mandatory under the law for companies to have outside directors on their board won’t be enough. A legal step like this needs to be accompanied by measures that ensure they can actually contribute to improving their company’s governance.